Educational Articles

Made in the USA: Escalating Offshoring Costs Make Onshoring a Better Bet For Some

J. Susan Ferrara
| May 10, 2011

The concept of offshoring, or moving parts of an operation to a foreign country, to save on expenses is not new. In fact, the trend began back in the 1980s, only to heat up intensely just two decades later. For years, U.S. companies struggling to increase their bottom lines found that relocating their manufacturing functions to developing countries, like China and India, as well as Mexico, made more economic sense than staying within the nation’s borders. After all, labor, which generally represents the largest outlay of any business, was very cost-efficient in those countries compared to the U.S. Raw materials, too, tended to be lower priced overseas, making it more beneficial to source materials from foreign nations, and not the homeland. And, until recently, weaker currencies versus the U.S. dollar made the idea of offshoring even more enticing, since American corporations would have to dole out fewer greenbacks to pay foreign employees.

But it seems that rising costs and risks for manufacturing merchandise abroad is prompting several U.S. companies to reassess their “offshore” business strategies, in favor of onshoring (or reshoring) production. Domestic tax incentives are helping some firms to stay put. On a broader scale, onshoring could also have a positive impact on the U.S. labor market, which saw about two million factory jobs disappear during the last recession.

For example, NCR Corp. (NCR) recently chose to bring back the production of its ATM machines to the U.S. from China and India. Mega appliance maker General Electric (GE – Free General Electric Stock Report) followed suit, deciding to invest millions of dollars to open several domestic manufacturing plants, where energy-efficient refrigerators and water heaters will be built. Industrial machine giant Caterpillar (CAT –Free Caterpillar Stock Report) also intends to make its products stateside, while automaker Ford (F) plans to set up supply facilities in the U.S. in 2012, so that it won’t rely solely on Mexico, India, and Japan for its components.

It’s not just production jobs that are coming back to the home front. Aerospace and defense behemoth Northrop Grumman Corp. (NOC) brought back from overseas a part of their IT and software support services to more rural, low-cost, regions of the U.S., where English-speaking skills aren’t lacking.

At the top of the “problem” list is foreign labor. Wages in emerging countries have increased rather sharply in the last couple of years, thanks to expanding economies. According to the U.S. Department of Labor, the hourly compensation for Chinese factory workers more than doubled from 2002 to 2008, from $0.57 to $1.36. Admittedly, foreign wages are still comparatively lower than those paid to U.S. workers. Still, the upswing in foreign labor costs is becoming a larger consideration of late.

Declining quality of goods is another major issue that faces U.S. corporations that have moved production overseas. Too often, foreign-made products are inferior in quality, a common complaint of consumers. A lack of quality control and poor working conditions in foreign factories, as well as an overwhelming order flow, are usually to blame. Production botch-ups could cost a company millions in lost sales and wasted inventory.

Companies offshoring production also aren’t necessarily being shielded from the recent pickup in raw materials prices. A shortage of cotton, for example, resulting from higher demand and weather-related damage to crop fields in China, India, Pakistan, and Australia, has pushed up global prices for the fabric. Retailers such as The Gap (GPS) and JC Penney (JCP), which depend substantially on foreign manufacturing, are being forced to pass some of those increases onto consumers through price hikes.

For numerous reasons, logistics can prove to be a challenge, as well, for firms that offshore operations. First, transportation costs are a big minus in the offshoring equation. As oil prices climb, U.S. companies with foreign plants will face higher shipping costs, which pressure margins. Second, distance inevitably makes it more difficult to adjust supply-chain processes, and to respond quickly to shifts in customer demand. Third, there’s a risk of encountering delays with deliveries, which can hurt business.

Currency exchange fluctuations certainly don’t help either. If a foreign currency gains strength against the dollar, it could place an additional burden on American businesses with overseas production facilities.

Intellectual property theft is a growing problem, too, with knock-offs, or fakes, made and sold on the market for reduced prices. This typically occurs when foreign contract manufacturers subcontract some of the work to cheaper producers that are less accessible and free from the supervision of U.S. firms.

Consumers might see more “Made in the U.S.A.” labels in the future, as American-made goods become more affordable. That might well help those companies prosper, and its stockholders too. Yet, despite the downsides to offshoring, we likely won’t see a movement to completely abandon it. Offshoring is still a more profitable alternative for lots of American companies, including heavyweights, like Apple (AAPL), which has its popular iPhones, iPads, iPods and other products assembled in Asia and other parts of the world, but notes they are designed in California.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.